How Financial Advisors Can Help Clients Prepare For Recession
The global economy has faced much turmoil in the past few years. Covid-19, especially with the couple of new variants, the sky-high inflation, war on Ukraine, rising oil prices, and drastically reduced economic growth, according to many experts, may be the tell-tale signs of a foreseeable recession.
Although the economy has fared better than most other countries, fear of possibly new Covid-19 variants and the continuously rising oil and gas prices is not helping alleviate the anxiety and wariness of clients.
Whether a recession is “normal” or inevitable (since many experts say it is a normal part of an economic cycle) clients and advisors would do well to maintain the attitude of “prepare for the worst and hope for the best.” However oftentimes, due to fear of a looming recession, clients often make common mistakes that can significantly hurt their finances.
To help your client avoid making emotional and rash decisions, as a financial advisor, it is your responsibility to do your research well and properly prepare your client for a downturn in the economy. Stated below are some guidelines to gear up your client and their finances for a possible recession.
Never Try To Time The Market
It’s common knowledge that investment decisions should never be made when one is emotional. Furthermore, history has shown that bull markets usually tend to last longer than bear markets. Yet still, one of the most common mistakes often rookie investors make is to cut back on your 401(k) or pull out of the market in a panic.
Even Warren Buffet by his own admission says he's not good at timing the market: "We haven't the faintest idea what the stock market is going to do when it opens on Monday. We've not been good at timing."
A “typical” recession lasts six to twelve months and most recessions tend to be much shorter. Selling fast as the stock market bottoms might seem like a good idea at the time since the market may continue to dip but in order for your decision to pull out at the time to be a smart one, it is necessary that you are right for step 2 as well: when to go back in and that is a challenge for even the most experienced advisors as they often can misjudge the rebound and risk suffering major losses.
Advisors should make investment plans that are long-term with expectations of the unexpected. When the unexpected does happen, you should be comfortable enough that your investment plan will weather the storm. Experts will tell you that economic growth is considered a long-term trend and though there may be a few hiccups along the way, you should be patient with the plan you have set in place to achieve your client’s financial goals.
Reduce The Expenses And Stockpile Those Savings
Whether the recession is imminent or not it always does good to take small steps to prepare for one and prepare to handle layoffs, tax increases, or income reduction. To prepare for such scenarios, it may be a good idea to start having your client find ways to cut down expenses and save up emergency funds as much as possible. One of the best ways to get the ball rolling is to start by asking your clients questions such as:
- What do you plan to do if your income decreases?
- Are you financially prepared to handle medical emergencies?
- What will you do if the rent goes up?
- Can you handle a major increase in gas prices?
It is wise to encourage your client to save where they can. Can any vacation plans they may have or pause any unnecessary renovations they have planned? Avoid spending on non-essentials as much as possible. When the economy is in a freefall, worst-case scenarios include major layoffs or inflation so high that people’s incomes can no longer keep up with it.
If saving up means changing, suggest your client change their housing situation then have your client do so although that might not be suitable for family-oriented clients. In other cases, side jobs may become essential to keep up with the rising prices. Switching to cheaper solutions may be of help in some instances too. Although it may be a good idea to set aside several months’ expenses, saving whatever they can help.
Keeping A Diversified Portfolio And Investing In Safe Haven Assets
Although economists will tell you that this may just be an “expected” downfall of the economy, financial advisors should be advising clients to keep their portfolios diversified for such situations. A diversified portfolio can weather a volatile market better than one that focuses on only stocks and bonds. One should consider delving into real estate, safe-fixed income options, equities, real assets, etc.
When investing, you should always think about long-term plans and ensure that a portfolio maintains a wide variety of asset allocations that can be adjusted to adapt to the current market situation. You should be confident that the financial plan you have set for your client, keeps in perspective the financial goals, the risks, and time horizons which will ensure that you do not have to make any major adjustments at the time of a recession. Most often than not when clients attempt to “de-risk” their portfolios as the market plummets, they end up turning temporary losses into permanent ones.
However, not tweaking your capital does not mean complete inaction or sitting idle on your hands. When looking to prepare for a recession, you can advise your clients to invest in “safe haven” assets that will help make up for any losses that may occur, if any. These may include some cash in bulk or short-duration bonds which may be 2 years or less as they tend to carry less uncertainty. Another most common safe haven asset includes gold as its value tends to increase dramatically when the economy is tumultuous. Do keep in mind that safe haven assets should best be purchased before a recession actually hits.
Pay Down Debt And Get Rid Of Your Credit Card Debt
One of the worst nightmares for credit card owners is their rapidly rising interest rates and debt piling up. If the economy is showing signs of heading toward a recession, have your clients pay their credit card balance as soon as possible before interest rates skyrocket to an all-time high making them regret purchasing that extra pair of shoes that they didn’t really need or that branded suit that they couldn’t afford.
Those who choose to live off credit card balance often spend more money than they actually should. Although it is a good practice to make those credit card monthly payments regularly anyway, taking special care of it during a looming recession will eliminate paying off costly credit card charges as well as improve your client’s credit score.
One way to manage that is encouraging your client to keep their credit utilization ratio (the amount of credit your client owes divided by your client’s credit limit) below 30%. The credit utilization ratio is considered one of the most influential factors on a credit score. However, for many keeping it low may require extra encouragement from your end or simply may not be possible without placing restrictions.
One way to get rid of that debt may be to acquire a low-interest personal loan for your client to get rid of that high-interest debt or make a call to the credit card issuer and request a rate reduction. Matt Schulz, chief credit analyst at LendingTree says “About 70 percent of people who asked for [rate reduction] in the last year got one,” Schulz said. “But far too few people ask.”
It is very natural for the economy to experience highs and lows. However, if the economic growth continues to decline at an alarming rate, the threat of a recession can drive advisors and clients into a frenzy forcing them to make emotional and irrational decisions. Although no one can predict or time the market (not even experts,) you can help your client prepare for a recession and make decisions that will protect their investments and make their portfolio recession-proof.